Financial planning. It can be a fraught topic with lots of things to do, a lot of things NOT to do, and often so many things as to be overwhelming.
I’ve built this “course” to help get a handle on their financial planning and in many cases DO their financial planning. It isn’t a big, convoluted thing. We’ve got 11 pieces. I’ll summarize them each here:
Cash Management: People like to accumulate accounts – bank, investment, retirement – you name it. Our goal here is to first SIMPLIFY. Make sure each account you have has a purpose and know what that purpose is. And accounts that don’t get closed and combined with others.
Cash Reserves: We’ve got a formula for your emergency fund. This is always the first investment you should make – in your own safety net. Can’t take risks without a safety net.
Estate Planning: Everyone wants to do fun stuff like invest and make money. But we manage risk first and making sure that you have a plan in place if something happens to you is the second most important investment you’ll make.
Life Insurance: Another formula! A quick calculation and we can tell you if, and how much, insurance you should probably have to protect your loved ones.
Savings: You’re ready to start saving – but where to put it? We built a waterfall to help you decide where to allocate your excess cash.
Retirement Accounts: ROTH? Regular? Taxable Account? We’ve built a quick matrix to help you decide how to allocate your retirement dollars.
Endowment: Maybe your monthly savings isn’t your major issue – you’ve got assets you need to allocate already. We’ll talk here about a different approach to investment planning
Investments – The Basics: An overview of the major areas of investments and what you’ll want to know about each.
Tax Planning – Make sure your tax situation is optimized! Our checklist will ensure that you are covered and not leaving money on the table.,
Investments – Execution You’ve got the basics, but once it is time to get the nitty gritty going, there’s some best practices you’re going to want to know.
Debt – The DEBT question. No, debt isn’t bad – but using it judiciously is key. We walk through what you need to know to be smart about using it.
We’ve also tried to break this into an “evergreen” format – and the fact that there are twelve parts is no accident. This should be an annual cycle. One piece each month – and at the start of the year, you restart the process. It should go easier the second time through, of course – but making sure that you are checking things on a regular basis is the key to a good financial plan.
This month's tasks seem silly but think of it like the Karate Kid waxing cars. You MUST get basic motions down if you're going to do flying jump kicks.
In this case – our "simple motion" is knowing how many accounts you have and what they are for. And we generally need to be more specific than just "cash" or "investing." Let's talk about cash, for example.
Do you have multiple checking accounts? And savings accounts? Can you articulate what each one is for? Or is the truth that you have accounts you opened because of some gimmick or sign-up deal and just forgot about it. Or you used to use it, but now you don't really and never finished shutting it down.
All those "orphan" accounts have two problems, one obvious and one not so obvious.
Obvious: You'd be surprised how much money you have not working because it is sitting around "just in case." Every $500 or $1,000 you have in an old account is money that isn't doing anything.
Not so Obvious: Having orphan accounts makes it VERY hard to make decisions about them. This is particularly true about investments. I get the problem ALL the time:
Them: I have $75k in a savings account, and I'm tired of it earning nothing!
Me: Great! You owe money on taxes this year; let's put it into an IRA for you and get it invested AND get a deduction!
Them: Welllll, what if I want to use it? I don't think I want to put it into an IRA.
Me: Ok, then let's get it into a Robo for you. Taxable, but still totally liquid. A nice 80/20 will get you some nice earnings!
Them: WAIT! I can't LOSE the money; stocks are risky and can go down in value!
Me: Well, that's how earning money works; you have to risk it to earn money with it.
Them: Well, I don't think I'll be able to sleep at night if I can lose it; it will drive me crazy!
Me: Ok, then leave it in the bank.
Them: But it is EARNING NOTHING! And it is driving me crazy that it earns nothing! What do I DO!?!
The underlying problem here isn't that they don't like risk or might use the money. The problem is that they don't have a defined goal for the money. This means they end up trying to use the same money to accomplish ALL their goals simultaneously: Earn, be liquid, be safe, grow for retirement, etc. But those are mutually exclusive goals.
When we know exactly what accounts we have, we can ascribe to each an explicit purpose, making decisions easy. That ease is what we are setting up for. It's the car wax that trains our hands to make the same move over and over.
To start – make a list of every single account you have. Then label it with one of the following:
Operating Accounts: These are checking accounts; you might have more than one if you have a business or share some with a spouse. But you should keep minimal cash in here, just what you need to "operate."
Emergency Fund: This is your emergency cash reserve. We'll calculate this number later for you, but you need one account that does not get touched that serves this purpose.
Deployable Capital: NOT to be confused with your Emergency Fund. Once we calculate a number for your emergency fund, you might very likely discover that you have more emergency money than you need. The overage gets rolled out elsewhere and is sitting waiting to be deployed in an investment.
Investment Account: This could be your IRA or 401(K), but it could also just be money you have set aside for an investment. We'll work on allocation later, but for now, we want to know what money is ready to be invested.
The goal is to trim down accounts and determine each account's "job. "And if an account doesn't have a job (or you have more than one doing the SAME job!), time to close it down and combine!
Checklist of actions
- Identify your operating accounts
- Identify your emergency fund
- Identify your investment accounts
- Create a Robo Account (or another taxable brokerage account) to use as your "Deployable Capital" bucket
- Consolidate any extra accounts to your deployable capital account and get ready to invest it!
OK, Cash reserve is our second task!
This month your mission is just to figure out how much money you need to have in case of emergency and how much you have that you can invest.
Below I’ve got the algorithm I use to help you arrive at a number. The old-school method of “six months of living expenses” also works, but my numbers are a bit more dynamic, and try to consider variables that affect the number. It more closely resembles the subject process that an advisor would use instead of a generic number of months.
Step One: Pick your starting point from the matrix:
Emergency Fund Matrix
30 – 40
40 – 55
55 – 65
$100k to $200k
$200k to $350k
$350k to $500k
Are you married?
Select your increase factors:
How many kids do you have?
Under 5 years old?
5 to 10 years old
11 to 15 years old
16 to 22 years old
Over age 23
Add up each increase factor. For example, if you have two kids under 5 years old, moderate job insecurity, and are married, your increase factor would be 30% (5% Kid #1 + 5% Kid #2 + 10% Moderate + 10% Married)
Multiple your starting point by 1+ your increase factor. (This was way easier when I made it in excel).
In case that is too tough, I made a sheet that should help: Click Here
Now that you have your target remember that list of accounts you made last month? You should already know which account is your emergency fund account. And there should be only one. And it should be in cash. Not a CD. Not a brokerage, just a plain savings account.
Yes, I know it won’t earn anything. That’s OK. The job of this money isn’t to earn. It is to BE THERE, no matter what. And it will do that job well.
Make sure to fund that account to that total and if you have excess, pull it out to your deployable capital account!
Everyone needs some sort of estate planning documents. This month we’re going to talk about all the "core" planning Documents:
- Revocable Living Trust
- Pour Over Will
- Durable POA
- Healthcare Directive
- Healthcare POA
What do these do? A few things:
Anyone who passes away must have their "estate" settled. This means, basically figuring out what you own and who gets it. All states have some version of a "Probate" code that decides this. And in the absence of direction, the courts will figure it out and distribute it all on your behalf. The three problems with this are A) it becomes public record and B) You don't get a say and C) it all gets distributed at once.
To solve this problem you can give instructions through your life. In some cases, this happens automatically: Life Insurance and IRAs are good examples. Both have designated beneficiaries, which means that when you die there is no need for a court to decide where the money needs to go, you already created a contract (either with the IRA Beneficiary Designation or with the Life Insurance Contract) that tells the world where the money needs to go.
A Revocable Living Trust basically allows you to do the same thing for all your OTHER assets like bank accounts, brokerage accounts and properties. It also allows you to create other trusts at your death - this is common for making sure that your kids don't end up with ALL your money too early. You can hold the assets in trust until, for example, all your kids graduate from college. You can really make up anything you want. You can also designate guardians for kids, or someone to manage your money after you are gone - things like that.
A Revocable Living Trust is a type of "Grantor Trust" - which means that the person(s) who create it can "revoke" or change it any time they want and they pay the taxes on the underlying assets. This means that practically speaking, you still own/control/manage all the assets.
This is not to be confused with Estate TAX planning which is an entirely different (although interrelated) issue. Estate tax planning often utilizes Irrevocable Trusts - which are NOT able to be changed and much more sophisticated.
The other items in the list are a little less complicated.
A “will” comes in different flavors. In the absence of a living trust, a Will can be used to direct where you want things to go. We usually call this a “Last Will and Testament”. It generally can’t create trusts and things though (except in some states, New York being the one that comes to mind) – it just tells the court where you want things to go. This still goes through probate though – in our three problems with probate it solves (B) but nothing else. But this might be totally OK for you.
In conjunction WITH a Living Will, you would likely have a “pour over” will. This will basically says “anything I own that isn’t in my trust, I leave to my trust”. This creates a “catch all” in case you didn’t title something into your trust it will end up there anyway and the trust document will control.
A Durable POA (Power of Attorney) basically gives someone else the authority to act on your behalf. Most commonly used between spouses but can also be used for elderly parents or a caretaker with someone who has special needs.
A Healthcare Directive tells medical staff (and your family) when (or when not) to resuscitate you. When to "pull the plug" and all that good stuff. These are CRITICALLY important - make these decisions well in advance. Making your poor wife/husband/parent/child make them for you while they are in the hospital is a jerk move. Don't be a jerk and don't make them make those decisions.
A Healthcare POA is just like a Durable POA, except it usually pertains specifically to medical situations.
OK, so how do I DO these things?
The first is to figure out which items you need. And wouldn’t you know it? We can pickle…. Errr have a quiz for that!
Are you alive?
Yes: You need a Healthcare Directive & POA
No: Cool, no worries then
Are you married?
Yes: You need a durable POA and basic Living Trust & Will
No: You need at least a basic Will
Are you planning to get married?
Yes: Make sure to update documents you have
Do you have kids?
Yes: You need a more complete Living Trust & Will
No: Lucky Duck
Do you have more than a $10MM Net Worth?
Yes: You might need Estate TAX Planning - contact a professional
No: Yeah, me either
Second – you need to get these documents drafted. If you do not have kids, you can use online tools like RocketLawyer to get basics done. I’m considering adding this service to my offerings, let me know if you’re interested! Your other option is to have an attorney do it. Generally a “core document” package will cost you between $1,000 and $2,500 depending on what you need to do. I’ll state this with emphasis:
If you have children you must pay an attorney to draft a package.
We don’t take chances in this scenario. We don’t mess around with band aids. If something happens to you it will be bad enough for your kids. Don’t make it worse. Whenever I do a financial plan this will ALWAYS be the first thing I tell you to do. I know it wasn’t here, because I’ve already yelled at most of you to do this. But on the risk/reward scale this is the best investment you’ll ever make.
Final note on this:
Estate Planning is not to be confused with Estate TAX planning. Estate tax is the tax you pay when you die – if you have an estate worth more than $11MM (although this is dropping to $5MM in a few years). It is a much more involved process and much more expensive. For younger people it might seem like a LOT of money, but compound earnings are tricky. The $11MM is indexed for inflation – (it isn’t exactly $11MM, I’m rounding for simplicity). But it is indexed at something like 3% - which means a young person who has a net worth under the $11MM threshold might have an issue. If your investments (and therefore net worth) compound (grow) at roughly 7% a year – you’ll be growing your net worth MUCH faster than the exemption. Roughly speaking:
If you are 30 years old, a net worth of $2.5MM has an estate tax problem
If you are 40 years old, a net worth of $3.5MM has an estate tax problem
If you are 50 years old, a net worth of $5.0MM has an estate tax problem
And that is if you DON’T SAVE ANYTHING – if you JUST earn 7% on the assets you already have. And those numbers get cut in half when the estate exemption drops in a couple years here. Something to think about! If you have this problem we can help, but it is not what we are talking about here.
Let us know if you have questions!
Checklist of actions
- Do our Quiz to see what docs you need
- Get them drafted
- Either contact a local attorney or
- Use an online system with our help
- Review if you think you’ll have an estate tax problem
This month’s topic is life insurance. I usually try to avoid this because holy cow there are LOTS of opinions out there. And every one knows someone who has started selling insurance and is trying to convince them how great it is and if they could just get a few numbers they could show you a proposal that…..
I am going to keep this very simple. Life insurance IS great and a really cool tool. It is also, without question, the most over used, over sold and over hyped financial product that has ever existed. Life insurance can do two things – it can be an investment and it protects you from risk. As with most things, if you try to have it do both, it will tend to both things very badly. So when looking at life insurance I take this as two VERY different conversations.
Investment side: Yes, you can overfund insurance (pay more than the actual cost to insure your life) and that extra money will go into an account of some sort. And you’ll earn something on that. It could be a fixed amount, could be a variable amount, it could even be directly invested in stocks and bonds.
The best part about it is that you don’t any tax on the earnings inside your life insurance policy. That is until you take it out. But since most banks and other lenders view life insurance values as the same as cash – they’ll loan you money (often up to 80% or 90% of the cash value) against the value. Getting a loan isn’t a taxable event – so you can effectively have earnings, pay not tax on them, and then borrow against the cash and not pay tax on it.
If this sounds familiar then yes, it roughly the same tax treatment as a ROTH IRA – and in fact using life insurance as a giant ROTH IRA for wealthy clients is something we do a lot.
But, and this is important – you must have a high quality, independent agent to be able to do anything useful with this. No offense, but there’s almost no scenario where the captive Northwestern Mutual or Mass Mutual agent is going to know the broader market and understand the products from across companies to build you the right policy. And you cannot DIY this. This is for trained professionals ONLY.
That’s all I’m going to say about the investment side. On to the protection side!
You should have basic life insurance policy that just covers the risk of you dying. Since we ONLY care about the death benefit you do not need whole life or universal or anything. Just use term. A 10 year to 20 year term policy is what I suggest for ALL clients (even the ones who have investment insurance as well) because it is the best, most cost effective way to get the basic protection you need.
But how much?
Glad you asked! We’ve got a worksheet for that: Click Here
If this gets too confusing, you know where to find us!
Checklist of Questions
This month is one of the more confusing months. But it is the one that helps alleviate the most concern, I think, in people’s day-to-day lives.
I’ve said it before, but just for the sake of clarity, I’ll repeat it here:
Most people have anxiety about money.
Most of that anxiety isn’t about not having enough, it’s about uncertainty in decision-making.
This uncertainty comes from a financial marketing machine that tells you to be afraid and preys on your FOMO by speaking in absolutes and making you believe that investments will solve your money problems or that there is a “best” investment.
By constantly being told that *this* investment is THE one, you constantly second guess prior decisions – or get paralyzed and don’t make any more decisions (even though inaction is an action).
The best way to eliminate this existential dread is to have a system and a plan and to have the confidence to follow it.
In previous months we did some activities that were one-off fixes (check your trusts, review emergency funds, check life insurance, etc.). This month’s task is actually repeating. We will design the waterfall of where to invest your money every month. We’ll design the waterfall, but the design of the waterfall isn’t the key. The repetitive application of that waterfall is the key. Each month (or whatever your trigger is) continuing deploying your money to the best uses (based on the waterfall) is the key. This is the first FP activity we’ve done that will repeat continuously – it isn’t a one-time fix (like, say, getting a trust).
But that repetitive plan will keep you on rails, keep your money working for you, and let you ignore the market swings and the marketing hype.
There are two steps to this – first, figure out your “savings,” then we run that savings through the “waterfall .”Easy right?
Your “savings” is the amount of money that you want to save. It’s the “excess” cash you have each month. This can vary by the month – and maybe it isn’t even monthly. Maybe you just live on your salary, and you save money every year when your bonus comes in. That’s totally fine.
I’m not here to tell you how to budget or spend. You already know that if you spend more cash in a year than you bring in, you’re going to have a problem.
I like to make the savings easy – just pick a working capital floor in your account. I usually only keep about $1,000 in my personal checking at the low point. If the low point starts to become more than $1,000 each month, I sweep out the amount above $1,000 and consider those savings. You could also pick a savings goal. Say you want to save $500 a month – you could just pull a flat $500 out of your account each month and run that through your waterfall.
Side note for Freelancers:
This can get more complicated. But it doesn’t need to. If you don’t have a separate business account, it is basically impossible (which is why we say SEPARATE THE ACTIVITY as the first dang thing you should do as a freelancer).
But assuming you followed directions – you just need to be more systematic in how often you move money over to the personal account. If you have an S-Corp, you can use your W-2 as the basic bill payments and then just sweep excess cash from your business account to your savings waterfall. Happy to chat with you about the mechanics of this, but the short version is that – as long as you are systematic, it should not be too tough.
OK, now we have a “savings” number. All we need to do is run it through the waterfall. I use, and have used, the waterfall concept for a long time because it makes a ton of sense and is easy to understand. Think of the waterfall fountain that fills up the top and then spills over to the next level down, and then when that fills up, it spills to the next level, etc etc.
Your savings is your fountain. Your waterfall has three levels:
Level One: Basics
Level Two: Debt and Insurance
Level Three: Investing
The first two are pretty basic and should get handled fairly quickly. Level One is covering your basics: If your emergency fund isn’t on target, it needs to be. If you don’t have a trust package, use your money to do that. If you don’t have your basic life insurance in place, you need to spend money on that.
Level Two can take a little longer. This level is about paying down debt. In this case, I’m not trying to get ALL your debt paid down. If you have a mortgage, just making the monthly payment is fine. We’re talking about the “bad” debts – consumer debt. If you owe money on credit cards or have student loans at or above 7%, we want to pay those down pretty quickly.
I also put the other “protections” type insurances here – Disability insurance is the most prominent, but long-term care insurance could also be here. This level, at its core, is about making your “base” more stable. This and level one are really about hedging risks. Investing involves risk, and we can’t take risks if a sickness can or job loss throws us into financial ruin. So making sure you are protected (with emergency funds and insurance) is the stable base from which we invest.
Level Three is we’re going to allocate money to investments:
First – max out your retirement plan – this could be your employer 401(k), a SEP, or a 401(k) you set up for your own business. The maximum will vary based on how you are set up – but the point is that we want at least $15k a year going to a retirement account of some sort.
Second – Taxable investments. This is the bottom of the waterfall and collects all the rest of the money. It can be tricky to pick how to invest here, but I use a balancing concept.
There are two main types of taxable investments: what I call the “enduring investments” and then the “opportunistic investments .”For the bottom, it isn’t really about how much in dollars but how much the ratio is between the two.
Enduring is going to be things like a stock/bond ETF mix. I use the big Robo players for this. Betterment, Wealthfront, etc. It’s basically anything that is going to be liquid. Usually, you’re looking for something like a risk of 4 to 7 out of ten. It will earn money and outperform inflation – but will still be fairly stable in value.
Opportunity is the things that have larger returns but have longer-term horizons and/or might be illiquid. Thin real estate, crypto, private equity investments, more aggressive stock strategies, etc.
I like to have one year’s income in my enduring investment account. So, level three looks like this:
If you have less than one year in Enduring, 100% of level three money goes here.
If you have at least one year but less than two, we want to balance between Enduring and Opportunistic. 50% goes to Enduring, and 50% goes to Opportunistic.
2x your annual income is really the MOST that we want in Enduring, so once it hits that, 100% of your money should be deployed into long-term investments.
And that’s basically it. Every time you have cash come in that is above your cash needs, run it through the waterfall. Rinse and repeat each month/quarter/bonus as necessary and then just relax. The money will sort itself out.
Retirement Accounts & Tax Deferral
OK – this month is an EASY one! Sort of. It will be a bunch of small, “quick hits” when it comes to all things tax deferral.
ROTH versus Traditional
I get asked this a lot – should I put money into my ROTH or my Traditional IRA (or 401(K), if you have the option). Just so we’re clear, we’re talking here about the trade off between a deduction now, tax-deferred growth, and paying later (Traditional) or no deduction no, but tax-free growth (ROTH). This is primarily a time value of money calculation. I use this table to help me figure out where the breakdown needs to be:
ROTH Versus Traditional
$51k to $100k
$100k to $150k
$150k to $250k
30 - 40
The other question I get a lot is “How much should I put into my HSA (Health Savings Accounts) or my kid’s 529 plan?”
My answer here is always about the same:
I like tax deferral. We all like tax deferral. Who doesn’t like saving taxes? But people forget the immutable law of taxation: The amount of tax saved is directly correlated to the amount of restrictions you apply to the money. So you can save money with a ROTH – but you can’t touch the money for at least 5 years and at least until age 60! That can be a big constraint!
I only care about tax deferral in the context of hitting my other goals.
People are way too enamored of tax “tricks”. You can’t use taxes to make a bad deal a good deal. Tax laws make good decisions better, they never make a bad decision a good decision.
I’ll say that again - Don’t let the tax tail wag the dog!
You should still be following your waterfall and putting money into all the various different buckets. If you’ve funded Levels 1 & 2 on your waterfall then feel free to do some HSAs and some 529s.
Don’t forget that to fund an HSA account you have to have a high-deductible plan. And most high deductible plans, post ObamaCare, aren’t that good.
Because these accounts usually have restricted use, though, make sure you don’t overfund them. 529s in particular. I would usually not target more than a couple hundred bucks a month, per kid, for their life into an account. I don’t want more than $150,000 in the account when they go to college.
“But the online tool says college will cost $300,000 a year when my kid is 18!!!!”
Right, well – you can compound any number for 20 years and at a decent rate and it’ll be scary. But we should not be expecting to pay for 100% of college from the 529 account. What if they need a car and not tuition? What if they want to start a business and need an investment, not college? The money in level 3 of your waterfall can be used for anything – but that 529 is college tuition and on campus housing only. Plus you can get pretty low cost debt to pay for college. I’d much rather borrow some money at 3% and keep my money earning 12% in real estate or the markets.
So, go ahead and fund them, but don’t overfund those items! Stay flexible – the most successful people are the ones who have the ability to maneuver: take advantage when opportunities arise and be able weather the storms that will come.